Canada: Mergers & Acquisitions In A More Uncertain World: Using The Companies’ Creditors Arrangement Act

You are probably aware of the useful restructuring and creditor
protection process available to insolvent entities in the United
States under Chapter 11 of the United States Bankruptcy Code. In
Canada, more than one insolvency regime is available in respect of
debtor companies in financial difficulty and those interested in
acquiring such companies or their assets. However, because of its
flexibility, the most commonly used Canadian regime for larger
debtor companies or complicated restructurings is the
Companies' Creditors Arrangement Act (Canada) (the
"CCAA").

Use of the CCAA can benefit both (i) insolvent debtor companies
seeking to restructure themselves while protected from their
creditors and (ii) buyers interested in obtaining the assets of
distressed companies on favourable terms and without some of the
procedural hurdles imposed in other M&A transactions.

In this article, we have focused on the second of these two
categories of benefits – what the CCAA can do for M&A
transactions. We will highlight those benefits and then briefly
explain what the CCAA procedure involves.

Key Benefits of the CCAA

Broad Judicial Discretion

Judges supervising proceedings by a debtor company under the
CCAA have broad powers and discretion to allow insolvent companies
protection under the CCAA to deal with their assets. This broad
discretion can allow for business combinations and asset sales to
occur that might otherwise not be possible.

Safe Haven for Directors of Distressed Companies

The directors of distressed companies face profound business
difficulties, which are compounded by the need to act speedily
within a dense thicket of fiduciary and statutory duties. Central
to these difficulties is the inability of the debtor company to
continue operations so as to realize or preserve the "going
concern" value in the insolvent business that would likely be
lost in a bankruptcy. If a distressed company's management is
of the view that a sale of all or a part of its business is the
best choice, this may not be possible in the available time or on
terms acceptable to potential acquirors if unpaid creditors
intervene or if shareholder approvals and regulatory or other third
party consents are first required. The CCAA offers the management
of troubled companies a clear, judicially blessed (i) stay of
proceedings by creditors and others, (ii) ability to continue
operations, (iii) time to work out a "fair and
reasonable" restructuring of the business, and/or (iv) time to
arrange for a beneficial and expedited sale of assets or shares
outside of bankruptcy.

Directors and officers still remain in control of the debtor
company during CCAA proceedings (albeit under the watchful eye of
the court approved monitor) and thus must remain cognizant of their
fiduciary and statutory duties. Management can legitimately ask for
and receive protection going forward as an incentive to remain with
the company during the process and CCAA orders often include
indemnification for them.

Safe Haven for Acquirers of Distressed Assets

The purchase of a distressed company or business can be equally
challenging for a perspective investor or buyer. Investment in a
faltering business may leave the investor ranking behind other
creditors in a bankruptcy. Rights acquired in distressed assets may
be judicially overturned as unfair to creditors. The CCAA
offer
a judicially blessed transaction, free from many later types of
challenge ― giving certainty and greatly reduced risk to
those interested in purchasing distressed companies or their
assets.

Asset Sales under the CCAA

In the normal course, the sale by a Canadian corporation of all
or substantially all of its assets requires the approval of its
shareholders by special resolution and may require other filings,
approvals or consents (for example, those of stock exchanges,
government authorities, joint venture partners or other contracting
counterparties). The CCAA can facilitate obtaining such approvals
or may obviate the need to obtain such approvals.

Pursuant to the CCAA, the court has the statutory authority to
approve a sale of the debtor company's assets, free and clear
of any security, charge or other restriction. The sale can occur
during the CCAA process either as a means to finance a
restructuring of the remaining assets of the debtor company or as
the final creditor-approved outcome of the CCAA proceedings. While
the courts prefer to see a sale of a business as a going concern,
judges may also approve CCAA asset sales in a more piecemeal
fashion, even where that may have the effect of liquidating the
debtor company.

When deciding whether to approve the sale, the court is required
to consider, among other things, whether the process leading to the
proposed sale was reasonable in the circumstances, whether the CCAA
monitor approved the process, the effect of the proposed sale on
creditors and other interested parties and whether the
consideration to be received is fair and reasonable, taking into
account fair market value.

Share Sales under the CCAA

An alternative to the sale of the assets of the debtor company
to an buyer or investor is a plan of arrangement involving the
issuance of new shares of the company to the buyer or investor, in
exchange for cash, debt or equity securities of the buyer or
investor, or a combination. The cash and/or debt and equity
securities can then be distributed to the debtor company's
creditors pursuant to the plan of arrangement. From a practical
perspective, the value provided to the creditors must be an
improvement over the recovery that the creditors could reasonably
have achieved through the exercise of their legal rights, such as
the appointment of
a receiver and the liquidation of the debtor company's assets
or a bankruptcy. Approval from the debtor company's
shareholders is not required ― merely approval from the
creditors (unless the court orders otherwise, which might happen in
the rare case that the existing equity is thought to still have
material value).

Where an acquiror wishes to secure control of a distressed
target, there may be instances where CCAA proceedings are not
feasible. For example, a great number of Canadian public resource
companies are headquartered in Canada but have the bulk of their
operations in foreign jurisdictions. CCAA proceedings in Canada may
not safeguard the company's operations in the foreign
jurisdiction, where obtaining equivalent protection will either be
impossible or very time-consuming. If a public issuer requires
urgent financing, it can undertake a sizeable private placement
that gives an acquiror control of the company while avoiding the
usual shareholder approval the TSX normally mandates for
significant dilutive financings, on the grounds of financial
hardship.

"Stalking Horse Bids"

The CCAA regime allows the purchase of assets by what is known
as a "stalking horse bid." This approach is well-known in
the United States, but relatively new in Canada. In this process,
the debtor company enters into an agreement with a potential
bidder, the "stalking horse bidder," for the sale of
particular assets or the entire distressed business. An auction or
tendering process is then undertaken to obtain the best offer
possible. The stalking horse bidder, by virtue of having placed an
arm's-length value on the relevant assets through its due
diligence, provides a price that underpins the auction process. The
stalking horse bidder enters the process knowing it may lose out to
a higher bidder and thus negotiates compensation for its
transaction costs, usually in the form of a "break fee"
that it will receive in the event its bid is not successful. The
stalking horse bidder resembles the "white knight" in a
takeover situation in that the break fee must be large enough to
justify making the bid but small enough not to unduly inhibit the
auction process.

Debtor in Possession Financing (DIP)

DIP financing is the provision of new or additional financing to
a debtor company seeking to restructure or sell its assets in the
context of CCAA protection. Typically, a DIP loan is a secured
revolving credit facility. It affords another means by which an
investor can gain access to opportunities that might not otherwise
be available by conventional methods.

The practice of DIP financing began originally through the
exercise of the broad discretion given to the courts under the
CCAA. It first appeared as an outgrowth of court-ordered priority
charges granted to lenders in order to ensure payment of the
administrative and restructuring expenses of the debtor company.
Such orders were initially controversial, and some judicial
decisions have suggested that if granted at all they should be kept
to a bare minimum: only enough to "keep the lights on at the
restructuring business."

As a result of amendments to the CCAA that came into effect in
2009, the power of the court to approve DIP financing is now
codified. The amended CCAA expressly allows the debtor company to
apply for an order to permit a lender to lend new money during a
restructuring, potentially on the strength of a so-called
"priming charge" that typically ranks ahead of existing
secured lenders. The amendments to the CCAA offer general guidance
by setting out a non-exhaustive list of factors to be weighed by
the court when deciding whether to approve the DIP financing,
including any potential prejudice to other creditors (particularly
the potential erosion of their secured positions through the
priority given to the DIP loan facility).

DIP lending may be attractive to investors for a variety of
reasons. If the lender is interested in ultimately acquiring some
or all of the debtor's business, providing DIP financing can
give the lender a significant and sometimes a pre-eminent role in
the management of the debtor company (through covenants in the DIP
financing documents) and the course of the restructuring
proceedings (as a senior secured creditor). This may be a critical
advantage in positioning an investor for an acquisition. Even if
the target assets are not purchased, DIP financing can be
profitable by virtue of the attractive spread that is often
available in such distressed situations, with the risk moderated by
a "priming" charge.

The Acid Bath of the Vesting Order

When assets are sold through CCAA proceedings, whether as part
of the financing of a restructuring or through a creditor and
court-approved overall plan of arrangement, a vesting order is
issued by the court. The effect of the vesting order is that the
creditors' claims to the assets included in the sale are
converted into claims to the proceeds of the sale, with the
creditors ranking in their pre-vesting order priorities in respect
of the distribution of such proceeds. The assets are transferred
free and clear of registered encumbrances, security interests and
claims against the assets, unless explicitly assumed by the
buyer.

A court order under the CCAA can also remove the need to obtain
certain consents and other requirements for closing a transaction.
This would include shareholder consent and consents from parties to
contracts concerning the assets. For example, the CCAA expressly
authorizes the court to assign contracts to an assignee,
notwithstanding restrictions on assignment in the contract, if
certain pre-conditions are met. In addition, certain regulatory
requirements under securities and other legislation can be avoided
or ameliorated through the vesting order. Another advantage flowing
from court supervision of the process is that the court will
expressly approve the transaction, thus reducing the risk of future
challenges to the validity of the transaction.

How the CCAA Regime Works

Initial Application to Court

To qualify to use the CCAA, a company must be insolvent and have
outstanding liabilities of $5 million or more. To initiate CCAA
proceedings, the debtor company must make an application to court
for an order imposing a stay of proceedings upon creditors and
authorizing the company to prepare a plan of arrangement to
compromise its indebtedness with some or all of its creditors.

In support of such application, an affidavit is prepared by the
debtor company that describes its background, financial
difficulties and the reasons it is seeking CCAA protection.
Usually, the initial order is made in the form of a draft order
prepared by the debtor company and its advisers, and submitted to
the court as one of the application documents, with little to no
input from creditors and other stakeholders. Affected parties
(including creditors) may apply to court to vary the initial order
after it is made.

Generally, an initial order does the following:

authorizes the debtor company to prepare a plan of arrangement
to put to its creditors;

authorizes the debtor company to stay in possession of its
assets and to carry on business in a manner consistent with the
preservation of its assets and business;

appoints a licensed Canada bankruptcy trustee as
"monitor", to do as the name suggests ― monitor
the business and affairs of the debtor company during the
proceedings and the restructuring process;

prohibits the debtor company from making payments in respect of
past debts (other than specific exceptions, such as amounts owing
to employees) and imposes a stay of proceedings (i) preventing
creditors and suppliers from taking action in respect of debts and
payables owing as at the filing date, and (ii) prohibiting the
termination of contracts by parties doing business with the
company;

authorizes the debtor company, if necessary, to obtain DIP
financing to ensure that it can fund its operations during the
proceedings, including setting limits on the aggregate funding and
the priority of the security; and

authorizes the debtor company to disclaim unfavourable
contracts, leases and other arrangements, to shut down facilities,
and to make provision for the consequences (for example, damage
claims) in the plan of arrangement.

The CCAA legislation itself provides that an initial order may
only impose a stay of proceedings for a period not exceeding 30
days. The debtor company, however, can ― and often does
― apply for a further order or orders extending the stay
of proceedings. Such extensions are generally obtained to permit
the stay to continue while the company's plan of arrangement is
presented to creditors and approved by the court. The duration of
proceedings under the CCAA usually is from 6 to 18 months but can
be completed in much less time.

The "Fair and Reasonable" Test

When considering whether to approve a plan of arrangement, the
court will consider whether the plan fairly balances the interest
of all of the debtor company's creditors, shareholders,
employees and other stakeholders and whether the plan represents a
fair and reasonable compromise that will permit a viable commercial
entity to emerge. The court will also consider factors such as: (i)
whether the proposed plan brings more value to creditors than a
bankruptcy or liquidation alternative, (ii) whether there has been
any oppressive conduct towards creditors, (iii) whether there is
the retention of jobs, and (iv) the public interest, in a
successful workout strategy. In deciding whether to grant the
approval order, the court will also look at the degree of approval
of the plan by the debtor company's creditors, noting that the
parties involved are generally the best judge of their own
interests. The court will generally favour a plan that has received
strong support from creditors.

Creditor Approval

For a plan of arrangement to be approved by creditors, a
majority of the creditors representing two-thirds in value of the
claims of each class of creditors, present and voting (either in
person or by proxy) at the meeting or meetings of creditors, must
vote in favour of the plan of arrangement. Considering that such
approval is required, and that the CCAA does not contain formal
"cram down" provisions, the determination of a
"class" of creditors is a key issue in CCAA
proceedings.

The CCAA sets out a "commonality of interest" test
when determining creditor classes. Aligning the interests and
grouping the creditors together properly is often crucial to
obtaining creditor approval. In a focused and efficient plan, the
right balance needs to be struck between sharing the pain of
compromise among creditors fairly, and minimizing complexity, cost
and delay.

Conclusion

By taking the time to understand the CCAA regime, those looking
to acquire the assets of distressed companies can do so relatively
quickly and economically. Not only can assets be successfully
acquired on good terms, but reasonable, relatively low risk returns
can be obtained by those willing to provide DIP financing to
insolvent companies. Significant changes in the economy call for
significant changes in business dealings. The CCAA regime will be
an important tool in many transactions resulting from the current
economic decline.

Board independence is a pillar of good corporate governance. It ensures that a corporation's management is properly monitored and that the corporation's decisions effectively balance the various stakeholders' interests.

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